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U.S. Startups Fight SEC Over Fundraising Disclosures

Startup companies that celebrated the passage of a U.S. law allowing them to solicit investors more more openly say regulators may undercut that move by requiring detailed disclosures of their fundraising.

An 80-year-old ban on advertising private investments ends today, allowing businesses to make public pitches to certain investors. At the same time, the Securities and Exchange Commission is weighing whether to require companies to file advance disclosures of those efforts. Failing to file could trigger a one-year disqualification from selling shares.

Startups say the SEC’s proposal was written with more established companies in mind. The cycle of fundraising at younger companies can be less predictable, relying on chance introductions and pitches at meetings of investors known as demo days.

“The market place is feeling a little unsure and insecure about how to move forward, particularly when they rely on venture fairs and demo days,” said Catherine Mott, a Pittsburgh investor who formerly led the Angel Capital Association. “This flies right in the face of the JOBS Act.”

The JOBS Act, the acronym for the Jumpstart Our Business Startups law, passed Congress in 2012 with the goal of deregulating how emerging companies raise money. The law jettisoned advertising restrictions intended to help ensure small investors aren’t lured into out-sized risks.

For the first time, companies raising money outside of a public offering will be able to advertise that they’re seeking funding. The pool of eligible investors will remain restricted to only those considered sophisticated enough to evaluate the risk, or wealthy enough to absorb a loss. The SEC defines such “accredited investors” as having with annual income exceeding $200,000 or net worth of $1 million excluding a primary residence.

Private offers are the biggest source of funding for small companies. The U.S. market for such securities was $903 billion last year, according to an SEC analysis published in July. The median amount raised was just $1.5 million.

The SEC voted in July to lift the advertising ban. At the same time, it proposed new rules intended to mitigate the risk of fraud created by allowing riskier ventures to solicit investors more directly.

The proposal would require companies publicizing their fundraising to file a form 15 days before seeking capital, a change from the current rule of that asks for the disclosure 15 days after of the first sale of shares. Any written advertising materials would have to be submitted to the SEC.

More Information

The form increases the amount of information companies must disclose, including additional details on how they will use the money. A company that fails to file the form could be banned from conducting a similar offering for a year.

“Basically, this is a booby trap, and lots of people are going to blow it,” said Joe Wallin, a partner at Davis Wright Tremaine LLP in Seattle who represents early-stage companies and investors, and blogs at Startuplawblog.com.

The proposal has also raised questions about whether business owners may run afoul of the new rules by participating in demo days, regional events where entrepreneurs field questions about their ventures and seek funding from private investors, Mott said in a phone interview. Demo days and similar events at universities can be advertised by e-mail or the Internet, Mott and others said.

The demo days events “technically violate” existing rules against advertising private investments, Heath Abshure, the president of the North American Securities Administrators Association, said Sept. 17 at a small-business committee meeting sponsored by the SEC.

“I’d like the SEC to either define general solicitation more clearly so entrepreneurs are very clear what they have to do, or carve out demo days and venture fairs,” Mott said in a phone interview.

SEC Chairman Mary Jo White said this week the commission would consider criticisms on the proposal, which passed last month over opposition from the agency’s Republican commissioners, including Daniel M. Gallagher. White has said the SEC will monitor how companies use advertising and whether it contributes to more fraud.

State securities regulators say the additional rules are needed to help address the risk of fraud. Private offers were the most common product leading to enforcement actions in 2011, according to the securities administrators group. Such investment offers typically come with limited disclosures about a company’s management and financial reporting, and the securities can be illiquid or restricted from resale.

‘Grandma and Grandpa’

“The investor I am concerned about is the one who flicks on his computer, and whoever has the slickest website can sell directly to that person,” Abshure said at the SEC meeting. “I’m talking mom and pop, grandma and grandpa, retail investors.”

The SEC’s proposal has attracted critical feedback from startups and investment portals such as AngelList LLC, which matches entrepreneurs with potential investors, and SecondMarket Holdings Inc., a platform where private shares are traded.

Adam Lieb, the founder of Seattle-based Duxter, a social network for gamers, said he wouldn’t use the new option to advertise for investors if he had to file a form 15 days in advance of the offering. He’d also worry about having to file advertising materials, such as Twitter posts or a blurb on the news website TechCrunch, with the regulator.

“It takes back a lot of what was cool about the JOBS Act and the idea of, ‘let’s make it easier for entrepreneurs to raise money from more people, faster, easier,’” Lieb said in a phone interview. “The new proposed rules kind of claw a lot of that back.”

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